Monday, August 07, 2006

"Oil" Is The Matter With You?

Oil touched US$76 a barrel on Aug 7 after producer BP shut down the biggest oilfield in the United States indefinitely, while anxiety about Middle East supply continued to run high. US light, sweet crude oil was up US$1.24 at US$76.00. London's Brent was up 98 cents at US$77.15 a barrel. Although I have reiterated that the underlying sentiment for equities is bullish, there will be obstacles and road humps along the way - the biggest being oil.

a) BP Plc shutting down indefinitely the Prudhoe Bay oil field in Alaska woll cut production by 400,000 barrels per day (bpd), or 8% of US domestic oil output. The closure was due to the discovery of severe corrosion and a tiny spill from a Prudhoe Bay oil transit line.

b) Tropical Storm Chris, which at one point appeared set to become the season's first hurricane, has failed to regain strength after being downgraded to a tropical depression late last week. One more obstacle down.

c) Tensions in the Middle East rose after Iran again invoked its oil exports for political leverage and Lebanon rejected a draft UN resolution meant to end the war between Israel and Hizbollah. A further spike in oil prices resulting from a broader Middle East conflict would drag an already slowing US economy into recession more easily now than a year ago. Logically, Iran would kill itself if it does anything extreme, but they have to use the oil card to force the ceasefire.

The worst case scenario would be Iran closing the Strait of Hormuz, a bottleneck in the Gulf region between Iran and Oman by which tankers from Kuwait, Saudi Arabia and the United Arab Emirates transit. This can easily propel oil price to above US$150. However, that situation is unlikely to happen as major powers would step in immediately as the oil price would affect everyone. In conclusion, while there are things to be concerned if we extrapolate our fears and dwell on worst-case scenarios, they are unlikely to pan out. The global economy (and bullish equity sentiment) should be able to withstand oil prices up to the US$90-95 before turning bearish.

Iran, the fourth-largest oil exporter, vowed on Aug 7 to expand its atomic fuel work and warned of a harsh response if the United Nations imposed sanctions aimed at halting enrichment. Hopes to move forward on Aug 7 with a draft UN resolution to end the war were dashed after Lebanon asked the Security Council to call for a quick withdrawal of Israeli troops, dividing council members and pushing a likely vote back until Aug 8. Israel views the UN draft favourably as it allows Israel to respond to Hizbollah attacks and did not order it to withdraw its troops from southern Lebanon. As a business blog, we have to monitor the situation as any more escalation, particularly involving Iran, would have to be reviewed judiciously.

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